Indexed Annuity Insights Fixed Indexed Annuities (FIA’s) have become very popular lately in retirement planning and for good reason. This type of annuity offers many features that other investment vehicles just don’t have. They offer safety of principal, income for life, tax-deferred growth, and in some cases an upfront bonus. Sounds too good to be true one might ask depending on one’s objective. With so many insurance companies offering these types of annuities it can be overwhelming trying to digest all of the different features an FIA offers. So let’s break down the basics of how this type of annuity works by first defining what it is and what it is not. An FIA is NOT a security like a variable annuity is. It is an insurance contract though it is linked to the performance of an index usually the S&P 500 but is not actually invested in the index. The insurance company is paying the contract owner a percentage of what the index does at the end of an anniversary date subject to the cap rates outlined in the contract. So as an example if you put 100k into an FIA that offered an 8% premium bonus upfront (true bonus) then your contract would be valued at $108,000.00 from day one. A year from the anniversary date the insurance company looks back at the performance of the index and the index strategies selected for the contract subject to the cap rates. So if the annual cap rate was 5% and the index gained 8% then the contract would lock in the 5%. Once it goes up it can't go back down after it’s locked in. So for the protection on the downside, they limit how much you can gain on the upside. Unlike a variable annuity where you assume the risk in an FIA, the insurance company assumes the risk. There are also monthly strategies that could have a much better outcome for the contract owner in a year where the index gained a lot.Some insurance companies offer a participation rate with a spread and these strategies have no cap rate at all. For example, if your participation rate is 100% with a spread of 1.5% this means you get 100% of what the index you're linked to does minus the 1.5% spread with no risk to your principal. The spread is never taken from your original principal and some insurance companies have participation rates as high as 160% in an index with a spread as low as 1%. This is a very good strategy for accumulation since you never participate in a bad year only good years and there are no fees since no income rider is attached. Most insurance companies allow free withdraws up to 10% of the contract value annually during the surrender period.Now what we just discussed is the contract value and how it can move up when the underlying index moves up. The contract value is the true value and death benefit that bypasses probate then goes directly to the beneficiary. There are also income riders that you can attach to the contract creating an income account value. The income account value is just a value used by the insurance company to calculate the contract owner’s payout based on their age. So for example, if you put $100,00.00 into an FIA that offered a premium bonus of 8% and attached an income rider paying 6% compounded interest then your contract value and your income account value would start at the same value of $108,000.00. Your contract value after the first year only moves up based on what the index does and any gains are locked in so once it goes up it can’t go down. Your income account value, however, grows at 6%, in this case, every year until you decide you want to turn on your income benefit. Again as an example let’s say in year 6 your contract value is $125,000.00 but your income account value is 145,000.00 then your income would be based on the $145,000.00 and if your payout is 6% then your fixed income for life would be $8,700.00 a year fixed. The focus here is not so much on the upfront bonus or contract value but on the end result of maximizing your income for life thus creating a pension for life.There are a few FIA's that have an increasing payout option that can increase with the index even after you started taking your annual income. This is very unusual since most FIA's have a fixed income once activated like a pension. Even if the contract value was depleted to zero the income can still increase based on the index. For example, let's say your starting income was $8,700.00 a year using an increasing payout option using the same 100k as your initial premium starting in year 6 of the contract. If there was an increase in the contract value based on your indexing strategy increasing your income to $9,200.00 the following year it would never move back down since it's locked in. Realistically though using this option your income would start a little lower than the fixed option but have the potential to move up and eventually surpass the fixed option. This strategy is more advantageous for someone with a long time horizon like a 65-year-old vs a 75-year-old. This increasing payout option helps with inflation since your income moves up with an index that can move up with inflation over time. Your income can only go up or stay the same in a bad year using this strategy. There are pros and cons to every investment so you should work with an experienced adviser well versed in this subject. Not all FIA’s are the same and some are better than others depending on your objective. Fixed Index Annuity: Preservation & Accumulation Graph Compared to S&P 500.